Super SIVs - A Fraudulent Attempt at Concealment

Over the weekend, the Treasury hosted talks to help a group of banks set
up a $100 billion fund to buy troubled assets in exchange for new short-term
debt. The banks hope to have the fund up and running within 90 days.

The problems stem from affiliated funds called structured investment vehicles,
or SIVs, which Citigroup and others set up as a way to make money without
taking the risk involved onto their balance sheets. Such vehicles are formally
independent of the banks that create them. They issue their own short-term
debt, usually at relatively low rates that reflects their high credit rating.
Then, they use the proceeds to buy higher-yielding assets such as securities
tied to mortgages or receivables from midsize businesses seeking to raise
cash.

[Mish comment. This is classic borrow short lend long madness. When done
with leverage it eventually blows up. Citigroup is an enormous player in
SIVs and the assets on which it has lent (mortgage backed securities), have
plunged in value]

Behind Treasury's concern were banks like Citigroup, whose affiliates owned
$80 billion in assets backed by mortgages and other securities. The world's
biggest bank, by market value, held the assets off its balance sheet and
was facing the prospect of either having to unload them in a disorderly fire-sale
fashion or moving them onto its books.

[Mish comment: One problem here is that Citigroup should never have been
allowed to hold those assets off its books in the first place]

Under the proposed rescue package Citigroup, J.P. Morgan Chase & Co.
and Bank of America Corp. will set up a fund, or "superconduit," to act as
a buyer of last resort. It will pay market prices for SIV assets in an effort
to prevent dumping.

[Mish comment: In other words, Citigroup is setting up a fund to buy assets
from itself. How convenient. By the way, when you are buying something from
yourself, who determines market price?]

Details are still being worked out but the oversight committee of the three
banks will set criteria for what the new fund, to be called the Master-Liquidity
Enhancement Conduit, will buy.

[Mish Comment: It will be interesting to see if there are "price guarantees"]

Banks would face huge losses if their affiliated funds were forced to unload
billions of dollars in mortgage-backed securities and other assets because
it would drive down prices and lead to big write-offs at the new, lower market
prices. Indeed, in the past several months, Citigroup's own affiliates have
sold some $20 billion in assets.

Some bankers objected to the plan, calling it an escape hatch for Citigroup,
which has more SIVs than any other bank, according to people familiar with
the situation. The bank has accounted for about 25% of the global SIV market.
As of August, assets held by SIVs totaled $400 billion.

[Mish comment: $400 billion in off balance sheet assets is preposterous.
Chuck Prince and his entire team should be fired. More to the point why should
Citigroup be bailed out? They were incredibly greedy and they should pay
the price]

Citigroup has drawn special scrutiny. The bank and its London office run
seven affiliates, or SIVs, that would be able to sell assets to the superconduit.

Bringing assets onto its balance sheet would be a big problem for Citigroup
because it would be required to set aside reserves to cover the assets. The
banking titan operates with a capital ratio that is thinner than peers.

[Mish comment: So what? Citigroup deserves to have a problem for acting
stupidly]

If the WSJ is remotely close to accurate on the plan details, this Super-SIV
bailout is nothing but a fraudulent attempt to allow banks and financial institutions
to keep questionable assets off their balance sheets.

Mandatory Auction Calls

On October 12 naked
capitalism was talking about another fraudulent way of keeping assets
off balance sheets:

Some financial firms have sought in recent weeks to avoid write-downs by
selling mortgage positions to hedge funds, with an agreement that allows
the hedge fund to sell them back after a set period. A hedge-fund trader
says his firm recently bought $1 billion of risky subprime mortgage loans
from Bear Stearns with a one-year pact, known as a "mandatory auction call," under
which Bear agrees to participate in an auction for the loans that will provide
the hedge fund with a minimum rate of return, according to a person familiar
with the situation. "They didn't want the mortgages on their books," the
hedge-fund manager says.

Such financial arrangements typically are considered proper if there's an
economic purpose to the trade and if risk is taken on by both parties. Legal
problems could arise if such trades are part of an attempt to conceal a company's
financial picture, regulators say.

When it comes to Bear Stearns, there is absolutely no economic purpose to
the trade. The only purpose was to conceal the current value of the asset.
This makes it fraudulent. The SEC should investigate but it likely won't.

Super SIV Doomed To Fail

On Saturday I commented Super
SIV Bailout Plan Doomed To Fail. As details emerge I have seen nothing
to change that opinion. The WSJ article has filled in a lot of blanks and
the remaining blanks will be filled in on Monday. But as of now this still
looks to me like a game of Don't Ask - Don't Sell.

Don't Ask - Don't Sell

Don't Ask what the asset is worth.

Don't Sell or you will find out and not like the result.

Of course you can sell to the Master-Liquidity Enhancement Conduit at market
prices, but market prices are not set by selling assets to yourself or by agreements
to buy assets a back at a guaranteed price as Bear Stearns is doing.

Let's go back to the beginning. This problem was caused by loose monetary
policy in conjunction with rules that allowed garbage to be kept off bank balance
sheets. The proposed solution is another scheme to keep garbage off bank balance
sheets. Logically the solution and the problem cannot be the same.

All indications are the Super-SIV bailout is nothing but a delay tactic that
simply cannot work. Furthermore, there is another crisis waiting in the wings:
commercial real estate. There is also a looming consumer led recession that
is coming no matter what the Fed does. For those reasons, attempts to delay
will only exacerbate the problem.

I do not know what the market will do on Monday. Perhaps this bailout will
sent the market to new highs. Bulls certainly have been stomping as if the
economic problems we face are temporary. Unfortunately the problems we face
are not temporary. Structural economic problems run long and deep. Whatever
final shape this bailout plan takes, it is doomed to fail over the long haul.
A collapse in consumer spending and commercial real estate will seal the fate.
Both are going to happen.